How Do You Solve a Problem Like Prada?

LONDON, United Kingdom — It's been a dire week for the luxury fashion sector.

After reporting lacklustre results on Thursday, Burberry shares dropped by almost 8 percent in intraday trading after failing to meet market expectations for full year earnings. Quarterly sales in the weakening Hong Kong market plummeted by 20 percent year on year — the third consecutive decrease. But Christopher Bailey, the company's chief executive and creative offer, is overseeing a business in the throes of a huge transformation, consolidating its brand hierarchy, reorienting its fashion shows and corresponding deliveries to overhaul the business for the lightening speed of the digital age.

LVMH also took the market by surprise with less than stellar results, weighed down by slowing in tourist arrivals in Europe following the terrorist attacks in Paris in November. While LVMH has a diversified portfolio that helped to soften the blow, the fashion and leather goods division showed a particular weakness, with sales at the group's flagship Louis Vuitton brand in Paris dropping by a whopping 10 percent. The continuing restructuring at Donna Karan and Marc Jacobs also contributed to the decline.

But it is the ongoing problems at Prada that are the most acute — and are the biggest cause for worry in a generally soft luxury market. This week, Prada again missed market estimates, making it the worst performing big luxury stock — share prices are down 29 percent over the last three years — after a sky-high much ballyhooed IPO on the Hong Kong stock exchange in 2011.

Operating a publicly-traded business means that Prada is now being held to account by scores of market analysts and major institutional investors, and the results have not been good. According to Bloomberg, Prada has failed to meet its own earnings forecasts in 11 of the past 12 quarters. Its profit margin has shrunk from 27 percent in 2012 to 14 percent last year.

Indeed, of all the major luxury brands, Prada seems the most exposed to the countervailing market forces — weakening demand in Greater China, slowing global tourism travel, changing consumer behaviour in the digital age — making it the basket-case of the luxury sector. Even if the brand has been on a resurgent creative streak of late, the business has critical internal problems to address as well.

So, how do you solve a problem like Prada?

In a bid to distance itself from a wholesale model and gain mega-brand status, the company has been on a retail roll-out that has taken its total store count to 618 as of January 31st of this year — and somehow, even in a slowing market, this roll-out continues unabated. It seems every other week I get a press release about a new Prada or Miu Miu store opening in Macau or Bangkok or Seoul.

Indeed, according to Exane BNP Paribas, between 2013 and 2015, Prada opened 21 new stores for a total of 265, with eight of Prada's new stores in China. Miu Miu, Prada Group's other major fashion brand, has opened 42 new stores over the same period for a total of 164 stores. In a market that has been slowing, these stores have failed to provide an adequate return on investment. This week Prada said it would offset this spate of new openings with store closures, but it seems this is a delayed reaction to a problem that the business could have, and should have seen coming. Over the same period, Burberry's store count was flat at 406 and Louis Vuitton's store count decreased by 17 to 453 stores.

What's more, the products in all of these new stores are not meeting the needs of the market, and analysts have criticised the brand for its narrow product offering, which does not have the same wide base of accessible products — perfumes, cosmetics, ties, jewellery — that most luxury brands thrive on. Prada says it is now re-orienting its merchandising and product assortment strategies to include more leather goods products at opening price points. Again, too little, too late.

But, I'd say the biggest underlying problem of all at Prada is one of mindset. In conversations with Prada executives over the years, I've often had the sense that there is a resistance to change or doing things differently — especially when it comes to embracing digital.

As reported elsewhere on BoF, in the five-year period from 2009 to 2014, online sales of luxury goods grew four times faster than offline sales. In fact, in 2014, nearly all luxury market growth came from e-commerce, with online sales registering the sharpest spike on record, reaching €14 billion, up 50 percent from 2013. Meanwhile, nearly three quarters of all luxury goods purchases, even if they take place in physical stores, are influenced by what consumers do online.

But at Prada, senior management has had a mind block, as if, somehow, the new rules of engagement simply do not apply to them. This kind of mindset in a market landscape that is changing radically, was bound to catch up with Prada sooner or later. Now, it seems it has.

Recently, Prada has started to think about the Internet, but I get the sense that they are only asking the questions now that other business started asking themselves 10 years ago. Can luxury be sold on the internet? Won't it be damaging to our brand? How can we use social media?

But according to a report by McKinsey & Company, "The question is no longer if and when luxury brands should embrace the digital opportunity, but how they should go about doing it… Embracing this new digital reality calls for a complete shift of luxury brands' approach to engaging with consumers."

In order to succeed in a rough and widely changing marketplace, businesses have to be able to pro-actively look into the future and think about reinventing themselves before the avalanche of change happens. Otherwise, you certainly face the consequences.